Make Room on the Shelf — One More Tax Reform Report

The release of a tax reform report from the White House leaves us with yet one more report analyzing ideas, but no closer to a better tax system.

In March 2009, Peter Orszag, then director of the White House Office of Management and Budget (OMB) announced that the President's Economic Recovery Advisory Board (PERAB), chaired by Paul A. Volcker, would form a Task Force on Tax Reform with a report due December 4, 2009. The Task Force was to focus on three areas:

The Task Force solicited public comment and received input from more than 300 individuals and organizations (PERAB Public Comment website). The group also held public-meetings webcast that were archived on the White House website.

The report was not issued until August 2010 because the Task Force wanted more time to get public comments (PERAB blog post, November 27, 2009). The final report (PDF) —The Tax Reform Options: Simplification, Compliance, and Corporate Taxation, explains and critiques over 40 options within the three categories noted in the title of this 118-page report.

This article provides additional background on the PERAB Task Force and summarizes some of the options that affect businesses. A critique of the report is offered along with the prospects for when tax reform might occur.

Task Force Caveats

Two observations about the Task Force regarding its place in the Administration and a limitation on the types and extent of reform proposals it was to pursue, help explain the Final Report.

PERAB versus President Obama: Early in its work and in its final report, the Task Force emphasized that PERAB is an "outside advisory panel and is not part of the Obama Administration" (Final Report (PDF), page v). This may seem puzzling since President Obama established PERAB within the Treasury Department to provide funding and support, and PERAB reports directly to the President. Members are not paid (other than travel expenses). Members were selected by the President to present diverse, independent, nonpartisan advice (PERAB website). The relevance of all of this is that we should not be surprised if there is any disconnect between the Task Force report and official White House revenue proposals, such as those in the FY 2011 "Greenbook" (PDF) or calls for additional stimulus provisions that tend to challenge simplification ideals.

Scope restrictions: The Task Force was not charged with recommending a "specific direction in tax policy" (PERAB blog post, September 30, 2009); nor was it to propose major reform (Final Report (PDF), page v). Instead, it was to present a variety of options and their pros and cons.
In addition, the Task Force was instructed to focus only on options that did not result in tax increases for married taxpayers with annual income below $250,000 or below $200,000 if not married. The Task Force interpreted this as meaning that groupings of options had to meet this parameter rather than each separate option (Final Report, page v).

Business-Related Options

The Final Report presents options within three categories. Options that are most relevant to businesses are listed and briefly explained below.

Simplification

Simplify recordkeeping and reduce compliance costs for more small businesses by allowing expensing of all purchases other than buildings.

Simplify the home-office deduction by allowing for a standard deduction.

Increase information reporting and source withholding such as for payments to independent contractors.

For all transactions, require small businesses to use a designated bank account that is separate from all personal accounts. The bank would issue an annual report of the account receipts and expenditures.

Clarify the definition of an independent contractor such as by repealing the common law rules and allowing the Internal Revenue Service (IRS) to publish guidance.

Make owners of limited liability corporations (LLCs) and S corporations as well as limited partners, subject to self-employment tax in the same way that self-employed individuals and general partners are subject to this tax.

Corporate Tax Reform

Reduce marginal corporate tax rates by:

Reducing the statutory corporate rate. The revenue loss — estimated to be about $12 billion annually for each percentage point drop in the rate — could be paid for through base broadening (see suggestions below).

Increasing incentives for new investment such as by allowing expensing of business assets.

Broaden the corporate tax base by:

Reducing the bias for debt over equity such as by limiting the deduction of interest expense that exceeds interest income.

Finding a technique to neutralize the tax treatment of corporate and non-corporate businesses. Since 1980, there has been a growth in non-corporate businesses and a decline in those operating as C corporations. Possible options include treating some businesses as corporations for tax purposes, or integrating the corporate and individual tax systems to eliminate double taxation of corporate income.

Eliminating certain tax expenditures such as the domestic production deduction (IRC §199), accelerated depreciation, special employee stock ownership plan (ESOP) rules, the exemption for credit union income and the low-income housing credit. Elimination of the §199 deduction would allow for the corporate tax rate to be reduced 1.1 percentage points while eliminating accelerated depreciation would generate revenue to allow for a three-percentage-point reduction (Final Report, p 78).

Pursue certain international tax changes such as:

Moving to a territorial system,

Moving to a pure worldwide tax system with a lower corporate tax rate,

Limit or end deferral with the current corporate tax rate or

Keep the current system but lower the corporate tax rate. These options might be combined with options listed above for broadening the corporate-tax base.

Critique
The options in the Final Report are not new but have been suggested by others in the past including by President Bush's Advisory Panel on Federal Tax Reform that issued a report in 2005. Some of the options have been introduced in Congress in the past, such as for a standard deduction for home office expenses (H.R. 3056 (111th Congress)). Numerous simplification proposals have been offered by the Joint Committee on Taxation and tax practitioner groups. For further information on past tax reform proposals, projects and studies, see the links in the box below.

The Final Report is useful in bringing renewed attention to some possible improvements to simplify the law, improve collections and address tax challenges corporations face in the global economy. More will be needed though to bring about reform. Missing items include the following:

Goals for reform: If a goal for changing the tax system is not articulated, it will be impossible to have meaningful reform or to assess the impact of any changes. The Administration and Congress need to articulate the key goals so that proposals can be evaluated on whether they will help reach that goal. For example, isolated international tax reforms without a goal in mind for how the system of taxing a global enterprise should operate, could lead to greater complexity and reduced competitiveness for U.S. firms.

Implementation plan: A plan is needed on how to implement change before continuing with piecemeal changes. For example, there have been several proposals in the past few decades to apply a set of tax rules to all businesses regardless of form (corporation, partnership, LLC or sole proprietorship). This idea needs to be examined thoroughly with a decision made as to whether or not to pursue it before making changes that only affect one type of entity. For example, if the corporate tax rate is reduced from the current top rate of 35 percent while other business entities face higher marginal rates, reform goals, such as improved international competitiveness and a reduced tax gap, might not be achieved.

Moving Towards Reform

The PERAB Task Force emphasized that it is not part of the Obama Administration. Thus, it remains to be seen if President Obama embraces any of the options or if members of Congress do. Otherwise, the Final Report will likely just take a spot on the large shelf of past tax reform reports by government and private groups.

With Congress and the Administration currently focused on what to do with the 2001/2003 tax cuts, provisions that expired at the end of 2009 and possible additional stimulus measures, we are unlikely to see any attention paid to true tax reform until at least 2011.

Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.